1. Silicon Valley Bank’s (SVB) failure was caused by the largest bank run in American history with a total of $42 billion in deposits withdrawn in less than 24 hours.
2. The failure of SVB and subsequentially, Signature Bank, marks one of the first true stress tests to the United States (U.S.) financial system since the 2008 crisis.
3. Congress is divided over the cause of these bank failures resulting in different perspectives on recent bank failures, leaving concerns about whether Congress can come together to help strengthen the U.S. financial system.
Introduction (What happened?)
After the failure of Silicon Valley Bank (SVB) and Signature Bank, The Senate Committee on Banking, Housing, and Urban Affairs held a hearing titled “Recent Bank Failures and the Federal Regulatory Response” on March 28, 2023. The next day on March 29, 2023, the House Committee on Financial Services held a hearing titled “The Federal Regulators Response to Recent Bank Failures”.
The issues for SVB go back years. Beginning near the end of 2021, Federal Reserve supervisors issued six supervisory findings related to SVB’s liquidity risk management. By May 2022, supervisors issued another three findings related to ineffective board oversight and risk management weaknesses. In mid-February 2023, bank staff discussed issues with the Federal Reserve’s Board of Governors highlighting SVB’s interest rate and liquidity risk.
On Wednesday, March 8, 2023, SVB attempted to improve its liquidity rate by selling $21 billion of its securities portfolio at a $1.8 billion loss. On Thursday, March 9, SVB announced it would raise funds by selling $2.25 billion in common equity causing its stock price to plummet 60%, losing over $80 billion in value from bank shares. These actions caused a shockwave among depositors, resulting in a bank run as depositors withdrew $42 billion in deposits in a period of just a few hours. According to Michael S. Barr’s testimony (Vice Chair for Supervision Board of Governors of the Federal Reserve System) on Friday, March 10, SVB had $100 billion scheduled to leave the bank by customer request. The bank did not have enough liquidity to meet the demand resulting in the bank’s closure by the California Department of Financial Protection and Innovation (CADFPI). CADFPI then appointed the Federal Deposit Insurance Corporation (FDIC) as receiver.
Similarly, due to SVB’s failure, Signature Bank began to experience large deposit withdrawals of $17.8 billion, leading to regulators’ fear of contagion. New York State Department of Financial Services (NYSDFS) decided to close Signature Bank on Sunday, March 12, and also appointed the FDIC as receiver.
What was the cause? (Senate vs House Perspectives)
When looking for where to place the fault for the banks’ failures, the Senate and House had opposing ideas.
The Senate Committee on Banking, Housing, and Urban Affairs hearing began by setting an alarming tone. Chairman Sherrod Brown began his opening statement by stating, “Most bank failures, while never a good thing, are generally not a big deal, but the quick collapses of Silicon Valley Bank and Signature Bank were no ordinary failures.” Senate leaders pinned fault primarily on the bank CEOs. The executives are the ones who should have known how the risks were building in these banks. Democratic leaders took this opportunity to jab at the Trump-era banking regulators, who rolled back regulations, including S.2155, stating regulators “made it their mission to give Wall Street everything it wanted.”
According to the Senate hearing, SVB failed because the bank’s management did not effectively manage its interest rate and liquidity risk. SVB had inadequate risk management and internal controls that struggled to keep pace with the growth of the bank. Federal Reserve brought up these risks to the bank and it failed to act on them. The bank’s failure to act led to a shock on March 8 when it attempted to adjust its liquidity position.
The House Committee on Financial Services hearing was distinctly different by setting a much more critical tone with a greater focus on federal regulators. Chairman Patrick McHenry began opening statements by criticizing the FDIC and the Federal Reserve, placing fault on the federal agencies’ failure to properly regulate and prevent these bank runs. Chairman McHenry acknowledged the banks were mismanaged but criticized both federal agencies for not having transparency in their decisions as regulators. Right from the start, Chairman McHenry points out Vice Chair of Supervision Barr began his job reviewing climate risk and capital standards for larger banks without mention of changes to bank supervision and liquidity provision, two matters relating to these bank failures.
According to the House hearing, the banking industry is heavily regulated and as regulators continually monitor the bank’s behavior, it should have been no surprise. SVB’s risky practices were on the Federal Reserve’s radar for more than a year and Federal Reserve failed to take appropriate action. Laws and regulations give the Federal Reserve the authority and ability to take supervisory and enforcement action when unsafe and unsound practices are present. The failure to take action is a clear failure of the Federal Reserve.
Reactions to government response
The Senate defended the FDIC’s decision to pay out and cover the 88% of depositors at SVB and the 90% of depositors at Signature Bank who were uninsured. Democrat leaders justified the FDIC’s actions by pointing to the public’s concern as small businesses and workers feared they would pay the price for other people’s bad decisions. Chairman Brown championed the FDIC’s actions claiming it increased liquidity, promoted confidence in the banking system, and protected the deposits of customers and small businesses – not the investments of executives and shareholders.
Conversely, the House was extremely critical of the failure of the supervisory actions of federal agencies. To the point of Vice Chair French Hill, 12 U.S. Code § 1818– Termination of status as an insured depository institution, gives the Federal Reserve the authority to shut down banks that are operating in an unsafe and unsound manner. Even S.2155, The Economic Growth, Regulatory Relief, and Consumer Protection Act states, “Nothing in this bill shall limit the supervisory authorities for safety and soundness in any way”. FDIC, bank regulators, and the state have substantial discretion to use their authority when banks are operating in an unsafe and unsound manner. So, for the Federal Reserve to be aware of SVB’s risky practices and fail to act under its clear authority is a failure of government response.
Proposed regulations and solutions
The Senate is now evaluating if the application of more stringent standards would have promoted the bank to better manage risk. New standards are now being considered, believing higher levels of capital and liquidity under those standards could provide further resilience or stalled the banks’ failure. During the Senate’s hearing the following regulatory changes were discussed:
- Proposing and implementing the Basel III Endgame Reforms, which will better reflect trading and operational risks in the Federal Reserve’s measurement of banks’ capital needs and long-term debt requirements for large banks.
- Enhancing stress testing with multiple scenarios for a wider range of risks and uncovering channels for contagion.
- Changes to liquidity rules and other reforms to improve the resilience of the financial system.
The House states the U.S. requires stronger emergency liquidity provisions available 24/7 for better private solutions, with clear and simple means for lending to entities who will remain solvent.
Looking toward the future
Overall, there is a clear difference in perspectives on recent bank failures in the Senate and the House. Democrats believe a crisis was avoided and emphasize laws and regulations passed have created a safe banking system. While Republicans point more towards a lack of proper supervision from federal agencies and will be conducting a comprehensive review and ongoing oversight of various agencies.
No one denies the mismanagement within these banks, but questions remain on whether regulators responded appropriately. The Federal Reserve was aware of risky practices, and it has clear authority to take action. The Federal Reserve failed to act and has failed in its supervisory role. Moving forward, the Federal Reserve will be conducting its own internal review of supervisory failures. However, this internal review is a clear conflict of interest, and a third-party investigation may be required.